An arbitrage firm (A) notes that a bidder (B) whose stock is selling at $30 makes an offer for a target (T) selling at $40 to exchange 1.5 shares of B for 1 share of T. Shares to T rise to $44; B stays at $30. A sells 1.5 B short for $45 and goes long on T at $44. One month later the deal is completed with B at $30 and T at $45. What is A’s dollar and percentage annualized gain, assuming a required 50% margin and 8% cost of funds on both transactions?
Case 2.8 UNITED AIRLINES AND US AIRWAYS
On July 27, 2001, the U.S. Department of Justice blocked the merger of United Airlines and US Airways. According to Attorney General John Ashcroft, “if this acquisition were allowed to proceed, millions of customers … would have little choice but to pay higher fares and accept lower-quality air service.” Legislators on Capitol Hill applauded the decision of the DOJ to block the merger. The view was that competition along the East Coast would be greatly reduced because United Airlines and US Airways are the only two airlines in many markets offering connecting services between cities up and down the coast. When the merger was announced in May 2000, the stock price of US Airways increased from $26.31 to $49.00, nearly doubling in price. The bid by United Airlines was for $60 in cash. As investors expected the deal to take a considerably long time to complete, and because there was a good chance that the deal might be rejected by the regulations, the stock price of US Airways traded at a fairly large spread relative to the agreed-upon price. When the DOJ blocked the merger, the stock price of US Airways immediately dropped into the teens, and in August 2002, the company filed for federal bankruptcy protection. Interestingly, before the year 2002 had ended, United Airlines had also filed for federal bankruptcy protection. As of early 2003, the surviv-ability of both firms is questionable.
The DOJ’s blocking of the merger rested on the case that it would greatly reduce competition along the East Coast because the merging parties were often the only two major airlines in some markets. Should potential competition, for example, arising from Southwest Airlines, a mover into the East Coast market, factor into the DOJ’s decision?
US Airways is a failing firm and has a substantial probability of bankruptcy. Should the antitrust authorities consider a “failing firm” defense from the merging parties? That is, should mergers be allowed to occur if otherwise the target firm faces bankruptcy?
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